December 2016 “ACCOUNTANCY”
Excessive regulation is the enemy of transparency

Government departments, lacking the relevant expertise themselves, often grant extensive powers to professional bodies responsible for overseeing the activities of their members. The chief problem with this growth of administrative (compared with constitutional) law is accountability. Given such powers, professional bodies hardly expect to be accountable to members subject to their scrutiny; nor can they sensibly be accountable to the civil servants who were clueless on what was needed, and granted them powers to get rid of the problem.

In framing constitutional law government is accountable to the public via Parliament – but when, as an easy option, it allows administrators to take on quasi-judicial roles, chaos ensues. Thirty years ago the Financial Services Act “deregulated” the activities of banks, brokers and money traders. Released from the arcane customs of the “old boy” network, they forged market-driven international links that, with the electronic revolution, created exponential growth and refashioned the City as the world’s premier financial hub.

the arcane customs of the “old boy” network

The irony is that deregulation (the populist epithet for laissez faire) engendered a new regulatory fever on a scale not witnessed before or since. The promised “light-touch” grew into a veritable industry in its own right. With its handmaiden, “compliance”, it spawned a rash of university degrees, diplomas, national and global qualifications and, inevitably, its own professional bodies – all playing starring roles in a pantomime of self-important administrative law, never subjected to independent scrutiny or cost-benefit analysis.

Our profession is a hybrid

While this paradigm is antithetical to operational effectiveness in any field, the accountancy profession’s regulatory mania arises from its hybrid nature: member firms undertake both accounting and auditing services – the former are enmeshed in the technical intricacies of “how to account”; while the latter, supposedly wearing an independent hat, are the verifiers.

Underlying all the self-created accounting complexity is the timeless “true and fair” yardstick. Does the labyrinthine superstructure of impenetrable stipulations, known collectively as IFRS, make corporate reporting measurably more intelligible? A colleague recently advised a client against hedging – only because the IFRS rules are so convoluted that the cost of financial advice and audit would far outstrip the amount of hedging required!

Consider “revenue recognition.”

Consider “revenue recognition.” This requires income and costs to be reported when, respectively, they are earned and incurred, regardless of timing of payment, while prudence dictates that if there is uncertainty you must provide for the costs, but exclude revenues. Simple enough. Yet the latest tortuous standard, while it keeps armies of technicians frantically busy, succeeds only in widening the gulf between IFRS accounts and accounts that might actually be meaningful to users.

Revenue recognition in practice

The more complex the rules, the more easily they may be exploited. For example, three former Tesco executives now face charges of fraud and false accounting relating to revenue recognition – in this instance, “supplier rebates” (kickbacks from suppliers conditional on sales targets being achieved). In Tesco’s case the rebates overstatement in 2014 produced fictitious profits of £263 million, and knocked £2 billion off its stock market value.

Supplier rebates had already been identified as an area of high risk by ex-auditors PwC, thereby accepting that intentional or unintentional error might materially compromise the accounts; but they noted that controls over this area were “in place”. PwC’s performance is currently under investigation by the Financial Reporting Council. (Presumably the five FRC members with past PwC connections will play no part.)

Similarly, when mortgage parcels were passed between banks in 2007, dramatically racking up debt, their auditors happily accepted them at face value because the “label on the tin” showed “Triple A”. Did they open any of the parcels, let alone sniff their contents? The whole world knows the answer!

In his book on the massive Equity Funding fraud Raymond Dirks wrote: “a frequently heard comment after the Equity Funding scandal became public was that ‘routine auditing procedures aren’t designed to detect fraud’. If routine auditing procedures cannot detect 64,000 phony insurance policies, $25 million in counterfeit bonds, and $100 million in missing assets, what is the purpose of audits?”

Any critical review of our profession’s background history might enquire what we have learnt from past mistakes.

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